State Street research has found that 62% of buy side firms require a roadmap to prepare for emerging derivatives regulation.
The research, carried out by the TABB Group, examines the readiness of buy-side swap market participants who collectively represent more then $10 trillion in assets under management.
The report entitled, Charting New Territory: Buy-Side Readiness for Swaps Reforms, describes the readiness to implement key measures of the swaps reform as contained in Dodd Frank and the European Markets Infrastructure Regulation and describe the heavy focus firms are placing on the clearing aspect of regulatory requirements while adjusting to new margin demands.
Key findings of the report include: margin requirements are the primary focus for buy-side firms when preparing for regulatory reform; financial strength is the number one factor when selecting a CCP; a drop in liquidity was cited as the most likely unintended consequence of regulatory reform; more than one-third of buy-side firms do not have the high-grade collateral required to enable swaps trading in a centrally cleared world and reporting is the regulatory component for which buy-side firms feel least prepared.
In preparing for derivatives reform, the report finds the buy side must address outstanding issues in areas of registration, capital/business standards, trading technology, selection of futures clearing merchant (FCM) or swap execution facility (SEF) and organized trading facility (OTF), and reporting. The report also explores the services and other factors that could influence decisions to choose an FCM, SEF, and a CCP.
As an unintended consequence of the regulation, the majority of respondents believe that the migration of bilateral OTC markets into a central clearing counterparty paradigm will drive margin and collateral costs significantly higher, which will in turn influence product selection and render some exotic trade structures extinct. 52% of study respondents believe liquidity will dip when the regulations are adopted, 38% think a collateral shortage will result and 31% foresee an increase in trade and pricing errors.
Clifford Lewis, executive vice president and head of State Streets eExchange business, notes the process of transformation is challenging and it dominates the buy-sides thinking. They see a long road ahead before there will be collateral-efficient clearing solutions, competitive electronic execution and increased volumes that mitigate concerns about liquidity, he says.
Most survey participants do not plan to begin clearing until the regulations are adopted, with 52% saying a target date would drive them to clear sooner and 45% citing credit concerns as a reason for clearing early. 81% of the firms surveyed intend to continue uncleared products.
When choosing an FCM, the most important decision driver is the capability to onboard clients and backload existing trades, followed in importance by collateral / margin services. The study indicates that the selection of CCPs is driven primarily by its relative financial strength, identified by 58% of buy-side firms as of high importance when selecting at CCP, followed by margin requirements and netting efficiencies.
Further unintended consequences of the regulations include the forced migration of execution from phone to electronic via SEFs/OTFs, which could dramatically enhance volumes in vanilla swap-products and usher in a radically different trading model, but multiple SEFs/OTFs, trade repositories and other systems will drive a need for much greater connectivity and infrastructure.
(JDC)